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November 22, 2004


Spitzer's "reign of force"

New York Attorney General Eliot Spitzer has been critiqued on these pages in regards to his campaigns against drug companies, mutual funds, and, most recently, insurers and insurance brokers. In today's Wall Street Journal ($), Henry Manne, dean emeritus of George Mason School of Law and a pioneer of the law and economics field, dissects Spitzer's actions in more detail.

Manne notes that Spitzer's campaigns put enormous pressure upon companies to change behaviors, regardless of whether their prior behaviors were actually wrong or anticompetitive:

Eliot Spitzer's current campaign against major insurance brokers and insurance companies has reaped massive media indignation, just as his "discovery" of a mutual-fund scandal did. No need to wait for messy trials in courts of law or lengthy studies by scholars; the returns are in, at least in the headlines, and Mr. Spitzer has won again.

But what if Mr. Spitzer is wrong, and what if none of the practices complained of was either unethical or anticompetitive?

Manne goes on to argue that there is, at a minimum, significant cause to believe that the harms Mr. Spitzer is attacking may prove illusory -- and that the remedies he has "won" may cause much more harm than good. In the mutual fund context, using arguments similar to those cited here in September, Manne notes:

[F]or all we know, Mr. Spitzer's remedies against the mutual-fund companies may be more costly than the practices complained of. Setting fees by fiat at below-market rates -- price controls we call that in a different context -- has never worked. Mutual-fund "governance" changes are generally costly jokes for all the effect they will have. Companies never implicated in any wrongdoing have been saddled with costly and unnecessary new regulations. And finally, large fines and restitution have been paid for violations which have been alleged and confessed to, but not yet sustained in a court of law.

Manne also cites to a 1979 article by Nobel Laureate Ronald Coase, whose article "The Problem of Social Cost" is the foundation for modern law and economics (3 Journal of Law & Economics (1960)), to argue that the "contingent commissions" at the heart of Spitzer's complaint against the insurance companies (brokers were paid extra sums for books of business if, over time, the claims solicited turned out well and/or further business followed from the initial sale) were economically defensible and that Spitzer's actions, again, could result in a less competitive market hurting consumers:

Nobel Laureate Ronald Coase once famously showed (Journal of Law and Economics 1979) how kickbacks in the so-called radio DJ payola scandal were really a legitimate, albeit superficially confusing, competitive device. Payola was essential, Coase explained, to preserving competition between record companies, and its demise was only sought by competitors who were injured by the practice -- not by consumers. There are eerie similarities between the two situations.

If the Coasian analysis is correct -- and no serious rebuttal has ever appeared -- we may witness the demise of specialized insurance-brokerage firms like Marsh & McLennan in favor of more integrated insurance companies who will do their own marketing. This is already rumored to have begun. Or we may see insurance brokerage firms beginning to acquire and operate insurance companies. In either case we would be witnessing a decrease in market specialization with a commensurate loss of economic efficiency. Mr. Spitzer would have succeeded in making the industry less competitive and less efficient, and insurance buyers will eventually pay higher not lower premiums.

The real danger Spitzer poses stems directly from his unaccountable power, outside the normal checks and balances our constitutional structures are meant to provide:

In an era of general acceptance of deregulation and privatization, Mr. Spitzer has introduced the world to yet a new form of regulation, the use of the criminal law as an in terrorem weapon to force acceptance of industry-wide regulations. These rules are not vetted through normal authoritative channels, are not reviewable by any administrative process, and are not subject to even the minimal due-process requirements our courts require for normal administrative rule making. The whole process bears no resemblance to a rule of law; it is a reign of force. And to make matters worse, the regulatory remedies are usually vastly more costly to the public than the alleged evils. . . .

But make no mistake: Eliot Spitzer represents, wittingly or not, an attack on the entire corporate free-enterprise system.

Those of us who are regular readers of this site and followers of our work at the Manhattan Institute's Center for Legal Policy are well aware of our long-standing concern that our normal regulatory and democratic structures are being supplanted by an unchecked and unaccountable "regulation by litigation." Those who want more analysis of the dangers of government-sponsored litigation should read our editor's newest book The Rule of Lawyers.

(Hat tip: Stephen Bainbridge)

Posted by James R. Copland at 01:19 PM | TrackBack (0)



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